California has in a serious problem. As we have seen, it has an unsustainable debt, an unsustainable budget deficit, and unsustainable unfunded defined benefit pension programs for public employees. Unfortunately, California does not seem to recognize its plight and does not have any idea of how to deal with it. It might be interesting to look at the problem from the perspective of a typical Californian family and how they deal with a similar problem.
Our family, the Browns, have an annual budget of $100,000. Unfortunately, they only earn $60,000 per year and must borrow $40,000 to cover all of their costs of living which include a defined benefit pension program. By the way, those numbers are relevant. The federal government borrows 40 cents of each dollar it spends. Even with this level of expenditure, the Browns realize they cannot meet all of their obligations. They are unable to fully fund their defined benefit pension program and do all the other things they want to do. They decide to put off to the future funding the defined benefit plan and, in so doing, they create an unfunded liability. So far, its looks a lot like California.
After a few years the Browns realize that the cost of borrowing $40,000 annually is compounding and they need to borrow more to meet their obligations and costs of interest. They still spend $100,000 dollars to support their lifestyle, they still do not fund their defined benefit pension program, and they have to come up with another $5000 per year to cover the interest. Their budget is now $105,000 per year. They still make only $60,000 and must now borrow $45,000. As time passes, the amount of interest they must pay not only grows, it becomes more expensive. They have to pay a higher rate of interest because their creditors are beginning to be concerned about the ability of the Browns to pay their debt. Therefore the interest rate they pay increases. Further, the loans they have made are overwhelming. Soon, the Browns conclude that their spending and obligations are unsustainable. It becomes clear that they cannot live as they have and begin to pay off their loan and accrued interest. Of course this does not even consider their obligation to deal with the unfunded liability for their defined benefit pension fund. They must do something to stop the bleeding. By the way, Californians do not realize they are actually past this point already.
In order to achieve a balanced budget over a reasonable period of time and pay back their debt, the Browns decide that they can no longer afford many of the things they have enjoyed in the past. For example, they can no longer pay for the gardener or, in fact, their yard. They sell the yard and fire the gardener. Unfortunately, they are still far from balancing their budget and have made no progress on funding the defined benefit pension. Something must be done.
The Browns have always been proud that they have been able to send their two children to a nice, private school. Nonetheless, it soon becomes obvious they will not be able to fund the school any longer. They are sorry that this will mean that teachers will have to be fired. They find that they cannot even afford the cost of borrowing books from the library. They can no longer afford to fund the library. Eventually, the library must close. While the Browns continue to earn $60,000 per year and continue to borrow money, they are still far from covering the deficit in their budget and their debt. While their neighborhood is not dangerous, they have always felt better having a home security system that provides for fire and police protection, they must forego these expenses they can no longer afford. They also feel badly but police and firemen must be laid off.
Now the Browns have given up their yard and gardener, the private school, the library and fire and police protection. You would think that should be enough. Not so. How about the unfunded liability for the defined benefit pension program and their large loans and accrued interest. The cost to fund and maintain the pension program and pay off their debt will make it impossible for the Browns to ever enjoy life without stress. They finally decided they must find a way to get out from under the defined benefit pension fund obligations. They know that when they do, even though they will still have significant debt, they can go back to a reasonable, but not lavish lifestyle. They want to once again enjoy the parks maintained by a park service. They also want to have good schools, libraries and fire and police protection.
The Browns finally terminate the expensive unfunded defined benefit pension program.
This has been a struggle for the Browns but they now live under a balanced budget and are paying back their debt that was incurred for unreasonable expenses. Interestingly, this story applies equally to California. The difference is that the Browns “get it” and California doesn’t.
